Oil Prices May Slip A Bit Lower, But Fed Will Stick To Rate Hike Plan: BCA

According to the January 13th Weekly Report from BCA Research, lower oil prices are a “game changer” for the global economy. BCA Research Weekly Report Managing Editor Mark McClellan and team also highlights the developing policy divergence between the Fed and the European Central Bank as he argues “the Fed is determined to stick to its current rate hike timetable, despite lower inflation expectations and possible ECB asset purchases.”

Cheap oil will boost global economic growth

The BCA team believes “cheap oil is a cyclical game-changer, at least for 2015.” They point out the IMF estimates that a supply-induced 20% decrease in crude oil prices will increase real global GDP by 0.5-to-1.3% over a 2-year period. Crude prices have already dropped by 46% since the end of June 2014, which implies a potential total GDP increase by the end of 2016 of 1.3-to-3.4% (or 0.6-to-1.7% of extra growth in both 2015 and 2016).

Of course, the actual impact on growth may be less, given that part of the decline in oil prices also reflects weakening demand, especially in emerging markets. That said, the stimulative effect will still be significant, but investors have continued to revised their growth estimates downward as oil prices dropped in the fourth quarter.

Lower oil prices won’t significantly impact Fed’s plan for tightening

McClellan et al. also highlight that the FOMC Minutes from the December policy meeting reinforced the message that sagging oil prices and lowered inflation expectations have not changed the Fed’s expected policy tightening timetable. The Fed believes that oil’s deflationary impact will only temporary, and solid labor market momentum will be enough reason to begin tightening by summer. Some FOMC members have opined that the “…boost to domestic spending coming from lowerenergy prices could turn out to be quite large.”

The FOMC set the bar very low in terms of inflation expectations. Rate hikes apparently remain on the table as long as core inflation does not fall and FOMC members are “reasonably confident” that it will reach 2% by 2016 or early 2017.

In the conclusion of the report, the BCA analysts note that “one of our lingering concerns last year was that the U.S. economy might not be able to sustain above-trend growth throughout 2015. However, the oil shock changes the growth calculus for the better, even net of the hit to the domestic energy patch.”